Credit tap runs dry for small biz

Periyaswami, a powerloom operator near Sankagiri, a small town in Tamil Nadu, was somewhat apprehensive.

He had applied for a loan of Rs 3 lakh from a finance company near his factory and was very hopeful of getting a sanction, just like his neighbour who had already got a loan of Rs 2 lakh from the same company.

But the branch manager of the company had just called him to say that the company may not have enough funds to disburse his loan as there had been some changes in government rules. All he understood was that the government did not treat him as ‘priority’ any more.

He dismissed any thoughts of going back to the local branch of a large public sector bank. They had already wasted five months of his time, before telling him that they could not sanction him a loan. So it may be back to the local moneylender, again, he thought despairingly.

NEW RBI RULES

There are hundreds of Periyaswamis, nay lakhs of them, with similar stories playing out in different parts of the country, triggered by the recent moves by the Reserve Bank to encourage banks to lend directly to the Micro, Small and Medium Enterprises (MSME) in the country.

The MSME sector consists of 26 million enterprises, which contribute to over 45 per cent of the country’s manufacturing output and a paltry 5 per cent of them have access to capital from the organised financial sector, as per the statistics of the Ministry of MSME.

Banks have traditionally treated the micro segment of MSME as high-risk customers and shied away from lending to them.

Into this gap have stepped in non-banking finance companies (NBFCs), some old established players and other recent entrants.

Hitherto, banks' giving term loans to the NBFCs for onward lending to the MSME segment could be classified as ‘priority sector lending’ (PSL) by the banks. (Banks are expected to lend up to 40 per cent of their total loans to specific segments such as agriculture and MSMEs to encourage financial inclusion).

The recent changes in the RBI guidelines aimed at redirecting funds away from NBFCs to MSMEs reduced the willingness of banks to lend to the former. NBFCs have been starved of lendable resources. Hence, the plight of those like Periyaswamy.

Efforts to put more funds into the hands of the disadvantaged seem to have had the opposite effect.

BANKS’ DIFFICULTIES

Why are banks reluctant to lend to micro enterprises? It’s not because of lack of efforts by the RBI.

In conference after conference, the RBI is seen exhorting banks to increase lending to the financially excluded.

But what is practised is decided by the manager of the local branch of the bank, in places such as Sankagiri.

Firstly, the bank manager does not have an effective means to assess customers who do not have conventional financial documents such as ITRs, bank statements, balance sheets, etc.

Most MSME customers do not have such formal documentation. Indeed, most of them do not have any government registration. The bank is hard put to even prove their existence on paper, even though they exist in reality!

The banking model also calls for the customer to make numerous visits to the branch, spread over a period of several months, as a part of the loan process.

As most of the micro enterprises are proprietorship concerns, run by the family, they are unable to devote time for these multiple branch visits. As one customer puts it to us “… and even after five months, there is no guarantee that I will get the loan.”

The loan sizes of the MSME customers are largely less than Rs 5 lakh and this also makes it economically less viable for banks to lend cost effectively to them.

The banks’ cost structure will need either the loan sizes to be larger or the number of customers in a branch to be much higher, both of which are difficult.

Attempts such as the Business Correspondent (BC) model have not yet proved to be successful in addressing the MSME segment.

Furthermore, the segment is looked upon as being rather risky to lend to, and this further reduces the motivation to lend.

How do NBFCs manage to lend to the MSME sector? The answer to this question goes back to the very reason for the existence of the NBFCs, which is that they are able to effectively serve specific segments which the banks are not well placed to do.

And the ones focused on the MSME segment have evolved their own risk policies and credit assessment methods to be able to address the needs of the MSME customers.

The Periyaswamis of India are more than happy to receive financing from the NBFCs, precisely because these NBFCs have understood their needs well and have catered to their capital requirements very speedily and efficiently, and at interest rates which the customers have found to be very cost-effective.

To truly encourage the growth of the MSME sector, the RBI would do well to restore priority sector status to indirect MSME lending by the banks to the NBFCs.

After all, it is more important that the micro enterprises are able to access organised capital, and less significant whether their funding comes from banks or NBFCs.

(The author is Founder & COO, Vistaar Financial Services Ltd.)

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